IRS Disclosures of Knowingly False Return Information is Subject to Civil Action for Wrongful Disclosure (11/24/12)

In Aloe Vera of America, Inc. v. United States, 699 F.3d 1153 (9th Cir. 2012), here, the Ninth Circuit addressed the application of the two year time limit for filing a suit for wrongful disclosure of return information.  Section 6103, here, titled Confidentiality and disclosure of returns and return information, generally requires that return information -- virtually everything the IRS knows about a taxpayer -- be confidential, with certain specified exceptions.  Section 7431, here, titled Civil damages for unauthorized inspection or disclosure of returns or return information, provides a taxpayer a civil remedy the IRS's disclosures of return information not authorized by Section 6103.  Section 7431(d) provides that the suit must be brought "within 2 years after the date of discovery by the plaintiff of the unauthorized inspection or disclosure."  The question addressed by the Ninth Circuit was when the limitations period begins.

The Court (with Judge Sidney R. Thomas, here, as author of the majority opinion) starts its exegesis with a crisp statement of the issue and the holding:

This appeal presents the question, among others, of what event triggers the running of the statute of limitations for a claim for wrongful disclosure of a tax return pursuant to 26 U.S.C. § 7431(d). We conclude that the statute of limitations begins to run when the plaintiff knows or reasonably should know of the government's allegedly unauthorized disclosures. We also conclude, in the circumstances presented by this case, that the statute of limitations did not begin to run when the plaintiffs became aware of a pending general investigation that would involve disclosures, but only later when they knew or should have known of the specific disclosures at issue. Applying these principles to the facts of this case, we affirm in part and reverse in part.

One of the permitted exceptions to the general requirement of confidentiality of return information is for disclosures to the tax administration of a treaty partner, "but only to the extent provided in, and subject to the terms and conditions of, such convention or bilateral agreement.".  § 6103(k)(4).  The disclosure in question was made by the IRS to the tax administrators of a treaty partner, Japan.  The Japanese tax administrator was the National Taxing Authority ("NTA").  The taxpayer argued that the IRS disclosed false information, thus violating § 6103 and permitting the remedy under § 7431.  The notion is that, even if the information disclosed is knowingly false, it is still return information prohibited from disclosure.

The factual background may be summarized as follows:  U.S. individual A owns USCorp (Aloe Vera).   A also owns, with a Japanese individual, B, a Japanese corporation, JapanCorp.  There were transactions between the two corporations and commissions paid to the individuals.  The IRS was concerned about whether all of the income was properly reported.  (It is not clear whether this concern was as a result of the audit of either or both the US-Corp or A; but it appears that, at the inception, the taxpayers were not aware of the IRS's concerns.)  The IRS wrote the NTA proposing a simultaneous examination of the two corporations and individual B.  In the letter, the IRS estimated that the two individuals had failed to report commission and royalty income from the companies of $32 million.  On 8/15/96, the IRS notified USCorp and A of the simultaneous exam.  The NTA would have notified JapanCorp and B of the exam.  This IRS notice was the first notice the taxpayers had of an examination.  Under their respective procedures, in 1997, the NTA and the IRS thereafter proposed adjustments.  At this point, there was and should have been no notice of the audits outside the respective tax authorities and the taxpayers.  However, on 10/9/97, a Japanese news source reported that the USCorp failed to report income to Japan of approximately $60 million (7.7 billion yen in Japanese currency), attributing the source to "tax sources" and the IRS.

USCorp complained to the U.S. Competent Authority that the NTA had improperly disclosed return information.  The U.S. Competent Authority investigated and found that the NTA had not leaked such information.  USCorp. then filed the § 7431 action with two counts:

In Count I, Aloe Vera alleged that the IRS had disclosed false information to the NTA in violation of 26 U.S.C. § 6103(a).  In Count II, Aloe Vera alleged that the IRS had further violated section 6103 by disclosing certain tax information to the NTA even though the IRS knew or should have known that the NTA would leak the information.

I focus in this discussion only on the Count I allegations, since the district court and the Ninth Circuit agreed that Count II did not properly meet the jurisdictional requirements because it did not "identify which disclosures were unknown to them as of October 6, 1997."

Now, focusing on Count I, the Count seemed to be related only to a claim that certain of the information provided the NTA was false and therefore subject to damages under § 7431.  The following are the steps in the Ninth Circuit's analysis.

1.  The Court first addressed the issue of whether the action was timely.  As noted, the § 7431 must be brought with a two-year period.  In an earlier appeal in the case, the Ninth Circuit had held that the 2 year period in § 7431(d) was jurisdictional (see materials on the distinction between a time period that is a jurisdictional requirement of the cause of action and one that is just a statute of limitations) and began to run when the taxpayer "discovers" the disclosure and not from the date that the taxpayer "realizes" that the disclosure was unauthorized.  "The question now before us is when the 'date of discovery' occurs and whether the statute of limitations begins to run on a single date of discovery for all disclosures."

a.  "The 'date of discovery' on which the § 7431(d) statute of limitations begins to run is the date when a plaintiff knows or reasonably should know of an allegedly unauthorized inspection or disclosure. This rule accords with the 'general federal rule': that a limitations period begins to run when the plaintiff knows or has reason to know of the injury which is the basis of the action."\ 

b. "[T]he term "discovery," as used in 28 U.S.C. § 1658(b)(1)'s statute of limitations, "encompasses not only those facts the plaintiff actually knew, but also those facts a reasonably diligent plaintiff would have known."  This is called an "inquiry notice" -- which means notice of information that would put a reasonable person on notice that the cause has accrued.  By inference, this same concept applies to the "§ 7431(d) statute of limitations."  (JAT Note: at this point, I won't quibble with the reference to § 7431(d) as a statute of limitations, although the court otherwise calls it a jurisdictional rule.) 

c.  Section 7431(d)'s inquiry notice "is not triggered by a single generalized event, but rather by the plaintiff's actual or constructive knowledge of each particular disclosure."  Quoting its earlier decision, "The court [upon remand] shall have jurisdiction over only those claims related to disclosures, if any, that were discovered within the two-year statutory period."  (JAT Note: notice the flip back to jurisdiction language.)  The Court states its reasons for possible multiple dates rather than a single when there are multiple disclosures. \ 

d.  The Court looked at the facts and concluded that the district court had erred in finding that B should have learned of the disclosure before certain documents were disclosed to B's counsel.  That is a factual resolution, so I won't address that further. 

e.  The Court did note, however:   

Furthermore, a taxpayer who knows that the IRS has disclosed his tax return generally has no reason to suspect that the IRS has also fabricated and disclosed a false statement. Thus, until the taxpayer knows or should have known about the disclosure of that specific, false statement, the statute of limitations does not begin to run on a claim of disclosure of false information, because the taxpayer has not discovered the existence of the disclosure.

2.  The Court then determined that, assuming jurisdiction (established in the foregoing steps of the analysis), the question is whether the district court properly granted the IRS summary judgment -- more particularly whether there were genuine material issues of fact yet to be resolved.

a.  This is the key analysis (case citations omitted): 

As we have also discussed, under § 6103(k)(4), return information may be disclosed to a foreign government that has a tax treaty with the United States, "but only to the extent provided in, and subject to the terms and conditions of, such convention or bilateral agreement." The Tax Treaty provides, in relevant part, that "[t]he competent authorities of the Contracting States shall exchange such information as is pertinent to carrying out the provisions of this Convention or preventing fraud or fiscal evasion in relation to the taxes which are the subject of this Convention." Tax Treaty, art. 26,¶1 (emphasis added). Thus, under the Tax Treaty, the IRS may lawfully disclose any return information "pertinent" to "preventing [tax] fraud or fiscal evasion." The IRS argues that even false information may be "pertinent" and therefore protected under the exception.
As a general matter, treaties of the United States are interpreted liberally to give effect to their purposes. Thus, under the Tax Treaty, any information that may reasonably be considered pertinent should be covered under § 6103(k)(4)'s disclosure exemptions.
In this case, the simultaneous tax examination by both countries was pertinent to the Tax Treaty's purpose of avoiding tax evasion, and the investigation of potentially fraudulent commissions was equally pertinent. The question is whether a knowing provision of false information can be "pertinent" to "preventing fraud or fiscal evasion."
"Pertinent" is defined as "[p]ertaining to the issue at hand; relevant." Black's Law Dictionary 1261 (9th ed. 2009). "Relevant" is defined as "[l]ogically connected and tending to prove or disprove a matter in issue; having appreciable probative value—that is, rationally tending to persuade people of the probability or possibility of some alleged fact." Thus, to be pertinent to fighting tax fraud, information must tend to prove or persuade that tax fraud or evasion has actually occurred.
Knowingly false information cannot tend to prove tax fraud. Such information does not lead to useful evidence, and it is certainly not competent evidence in its own right. Thus, information known to be false cannot be subject to protection as "pertinent" information under the Tax Treaty. One of § 6103's main purposes is protection against malevolent government disclosure. Congress intended § 6103 to limit disclosure of tax information to narrowly defined circumstances. A definition of "pertinent" that allows the IRS to knowingly disclose false taxpayer information would eviscerate the statute's purpose. Known falsehoods are not pertinent to tax investigations, and knowing disclosures of such false information, even to a treaty partner, is actionable under § 6103 and § 7431, as the district court properly concluded. The knowing provision of false information can never further the purposes of a tax treaty.

3. The Court then analyzed the allegedly false information.

a.  The IRS's "estimate" of $32 million of income in the original simultaneous examination proprosal.  The Government urged that an estimate by its nature cannot be true or false.  But, the Court said that begs the questions.  Estimates can be "objectively false" if "the communicator knows it is not true."  That is a fact issue that cannot be resolved on the present record by summary judgment.
b.  The IRS's statements that commission statements on sales of product by U.S.-Corp.  This claim was based upon redacted notes from a presentation by the IRS to NTA.  "The district court determined that the notes, the audit, and deposition testimony were insufficient, concluding that 'the Court is not willing to hold the United States liable for intentional falsehoods based on notes taken by two different attendees of a meeting—attendees who admitted to the weakness of their notes.'"  The Court said that the notes were sufficient to avoid summary judgment on the issue of whether false information was knowingly disclosed.

8.  The Court then rejected the Government's "good faith" argument.  The statuate provides an exception to civil liability from a disclosure "which results from a good faith, but erroneous, interpretation of section 6103." § 7431(b)(1).  The Court rejected an interpretation of that exception to exempt a knowingly false disclosure.

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Now, to engage in esoterica, I promised to address the issue of jurisdictional time limits versus statutes of limitations.  The Court in Aloe Verde clearly held that the § 7431(d) time limit was jurisdictional, although it refers to it as a statute of limitations.  The following deals with that issue in the context of the analogous 2 year time periods for refunds (e.g., two years after denial of a claim to file the refund suit and limitation upon the amount of refund to taxes paid within two years of the claim) are jurisdictional.  The following is from my Federal Tax Crimes text (only 1 footnote included:

2. Statute for Filing of the Claim for Refund.
a. General.
Just as there are statutes of limitation on assessment and collection taxes, there are also statutes of limitation on taxpayers claiming tax refunds from the Government.  There are two applicable rules. 

First, there is a statute of limitations for filing the claim for refund.  A claim for refund must be filed within three years from the time the return was filed or two years from the date the tax was paid, whichever is later, and, if no return is filed, within two years from the date of payment.  § 6511(a).  Read literally, this means that a taxpayer can file a return 40 years late and qualify under this first rule. I hope readers will instinctively say something must be missing here, for statutes of limitations do not normally allowing such lengthy lapses before the claim must be pursued.  The answer to that concern is in the second rule to which I now turn. 

Second, there is a statute of limitations on the amount of tax that can be refunded if the claim is timely under the first rule.  The IRS may only refund the amount of tax paid within three years plus the period of any extension and, if the foregoing rule does not apply, then it may only refund the tax paid within two years of the date of the claim.  § 6511(b)(2).  fn703

fn703 For the esoteric application of these rules in the context of jurisdiction for a refund court (a district court or the Court of Federal Claims) to the issue of whether these rules are jurisdictional or just bases upon which to deny a refund with a court otherwise having jurisdiction, see Murdock v. United States, 103 Fed. Cl. 389 (2012).  It is not clear to me whether, from a real world perspective, it makes any difference whether a refund claimant loses his or her suit for refund because of jurisdiction or on the merits of whether it has met these rules, which in any event result in the case being dismissed.  But the Murdock court thought it important to struggle with  these concepts, all the while pouring the refund claimant out.  The Supreme Court has recently struggled with the distinction between jurisdictional and statutory time limit requirements in Henderson v. Shinseki, ___ U.S. ___, ___, 131 S. Ct. 1197, 1202-1203 (U.S. 2011), the Court noted important consequences in the distinction, including that jurisdictional rules must be applied by the courts even if not asserted by the parties and other consequences.  The Court offers no clear guidance except that (i) a rule should not be treated as jurisdictional unless it governs the court’s adjudicatory capacity and (ii) so-called “claim-processing rules” requiring procedural steps at specific times should generally not be considered jurisdictional.  I don’t know if this will change the historical perception of the refund timing rules as not being jurisdictional, but I don’t dwell on it further now because I don’t think it makes a lot of difference in the tax universe.  I do note one prominent instance where, over the parties objection, a court did invoke what it perceived to be a jurisdictional rule – the full payment rule of Flora v. United States, 357 U.S. 63 (1958), aff'd on reh'g, 362 U.S. 145 (1960) – to dismiss a case.  Shore v. United States, 26 Cl. Ct. 829 (Cl. Ct. 1992).  The dismissal turned upon the proper interpretation of the jurisdictional rule.  On appeal, the holding was reversed, because the court of appeals interpreted the rule differently, but did not quarrel with the rule as being jurisdictional.   Shore v. United States, 9 F.3d 1524 (Fed. Cir. 1993).